The European Commission has submitted a report to the European Parliament and the Council on EMIR. The Report recommends a number of changes to EMIR which, if implemented, will impact, among other things, on EMIR's application to non-financial counterparties (NFCs) and small financial counterparties. However, the Report also recommends that there should be no fundamental change to EMIR's core requirements, which the Commission considers remain integral to ensuring transparency and mitigating systemic risks in the derivatives markets.
EMIR and NFCs
EMIR seeks to promote transparency and standardisation in the over the counter (OTC) derivatives market and reduce systemic risks through the imposition of clearing requirements, margin requirements, operational risk mitigation requirements, and requirements for trade repositories and central counterparties. It applies to nearly all users of OTC derivatives, including any counterparties authorised under EU financial services frameworks ("FCs") and NFCs established in the EU.
EMIR requirements applicable to NFCs differ depending on the level of an NFC's nonhedging activity in OTC derivatives. When such activity of an NFC exceeds certain thresholds, the NFC ("NFC+") becomes subject to requirements similar to those applicable to financial counterparties. In particular an NFC+ is subject to EMIR clearing and margining requirements, whereas an NFC that does not exceed the relevant thresholds ("NFC-") is exempt from those requirements. All NFCs are subject to EMIR operational risk mitigation requirements such as those relating to reporting and confirming OTC derivatives.
The Report recognises that NFCs are, due to limited resources and experience, facing significant challenges in meeting their EMIR requirements, particularly the reporting requirement. It also considered that the current EMIR approach to NFCs may not substantially reduce systemic risk. The Report recommends considering whether to remove NFCs from the scope of the operational risk mitigation requirement and simplify the reporting of their transactions. In this respect it proposes that possible options to be explored are whether FCs should report derivatives data on NFC's behalf, FCs should ensure that operational risk mitigation requirements are applied for transactions with NFCs and NFCs should be exempt from reporting their intragroup transactions.
The Report also recommends giving further consideration to whether the clearing and margining requirements should capture any NFCs, or only some of them based on the volume and type of their activity in derivatives markets (whilst noting that certain NFCs may be reclassified when MiFID II is implemented, scheduled for January 2018 (here)).
EMIR and Small FCs
It is widely recognised that small FCs are facing significant challenges in establishing the access to clearing necessary to meet the clearing obligations. As set out in a previous briefing (here), the European Securities and Markets Authority recently proposed prolonging the phase-in of the clearing obligations for the smallest financial counterparties until 21 June 2019 because of these difficulties.
In its Report, the Commission recommends considering actions to address the obstacles to central clearing including:
- the leverage ratio requirements anticipated by clearing members under the Capital Requirements Regulation 575/2013 which are perceived as making client clearing services too costly to offer;
- the lack of both flexibility and certainty around segregation and storage options; and
- transparency intended to be achieved through trade reporting and reducing disproportionate costs and burdens. Among other things, these recommendations cover:
- simplifying and streamlining the trade reporting requirements;
- including a mechanism for suspending the clearing obligation in response to market turbulence or resolution situations;
- mandating regulators to endorse initial margin models so that parties to noncleared OTC derivatives can be confident that their calculations are fully compliant with applicable requirements;
- reviewing the application of the clearing requirement to contracts entered into before that requirement takes effect (frontloading) and the application of the operational risk mitigation requirement to intragroup transactions; and
- considering whether the current exemption for pension scheme arrangements from the clearing requirement could be prolonged or made permanent without compromising EMIR's objective of reducing systemic risk.
- in the case of some small FCs, the fact that their limited activity in OTC derivatives is such that it is not commercially viable for them to establish clearing solutions.
In the Report, the Commission makes a number of other recommendations which are intended to facilitate the predictability of margin requirements, promote the transparency intended to be achieved through trade reporting and reducing disproportionate costs and burdens. Among other things, these recommendations cover:
simplifying and streamlining the trade reporting requirements;
including a mechanism for suspending the clearing obligation in response to market turbulence or resolution situations;
mandating regulators to endorse initial margin models so that parties to non-cleared OTC derivatives can be confident in their calculations are fully compliant with applicable requirements;
reviewing the application of the clearing requirement to contracts entered into before the requirement takes effect (frontloading) and the application of the operational risk mitigation requirement to intragroup transactions; and
considering whether the current exemption for pension scheme arrangements from the clearing requirement could be prolonged or made permanent without compromising EMIR's objective of reducing systemic risk.
The Commission will propose a legislative review of EMIR in 2017 that will be accompanied by an impact assessment which will consider the various issues raised in the Report in more depth.
You may access the Report here.